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Tuesday, May 3, 2011

The People's Budget: Cutting the Deficit the Progressive Way

In previous posts, I have discussed bipartisan attempts to find a fiscal policy compromise (here and here), and also Republican plans for closing the budget gap through spending cuts alone (here and here). Today's post turns to the less widely publicized People's Budget from the Congressional Progressive Caucus. What is there to like about the progressive fiscal plan, and what not to like?
First what I like. On the spending side, the People's Budget does not limit itself to swinging a meat-ax at tiny targets like NPR and AmeriCorps within the 12 percent of the budget that is made up of discretionary nondefense spending. Instead, it goes after some really juicy chunks, including defense. Not just at waste, fraud, and abuse in the military budget, either. It comes right out and proposes an orderly but swift end to the military adventure in Afghanistan, thereby saving something between $400 billion and $1.6 trillion, depending on what baseline you compare it to. But the progressives do not really have a monopoly here. Concerns that the United States has not gotten its money's worth from wars in Iraq and Afghanistan are increasingly voiced on the Republican side of the aisle, including like Ron and Rand Paul, Jason Chafitz, and Walter Jones.

Next, the People's Budget takes aim at the nation's infrastructure deficit. As I argued in an earlier post, cutting infrastructure investment below what is needed to cover depreciation, as has been done in many areas, is an illusory way of improving the national balance sheet. What is saved in terms of reduced financial liabilities is offset by more rapid depreciation of real assets like bridges, dams, and power lines. In fact, since deferral of needed maintenance almost always means greater spending later when something breaks, cuts to infrastructure spending often end up making the nation's consolidated balance sheet weaker, not stronger. On the whole, without endorsing every line item, I would count the $1.7 trillion added to infrastructure investment over ten years as a plus for the People's Budget.

On entitlements, the People's Budget recognizes, as every observer must, that any realistic plan for fiscal consolidation must do something about the projected growth of government health care outlays. The Republican budget plan deals with this problem largely by shifting the cost of Medicare from the federal government to senior citizens themselves. There are relatively few cost-saving measures in the Republican plan except for malpractice reform and a vague hope that competition will force costs down in the future, even though it has not done so in the past.

The People's Budget takes cost saving in health care more seriously. Its initiatives include adding a public option to the array of private plans to be offered on health insurance exchanges and allowing the government to bargain with pharmaceutical companies over drug prices. Big insurance companies and big pharmas are terrified of these ideas: They might work!

The experience of countries like France and Germany shows that when a full array of cost-saving strategies are used, it is possible to provide better quality health care at lower cost, and to do so without moving to British-style, single-payer, "socialized medicine." The People's budget picks up some good ideas that have been shown to work elsewhere, although more could be added.

Let's turn now to the revenue side of the People's Budget. Out of $5.6 trillion in projected deficit reduction in the progressive plan, $3.9 billion, or nearly 70 percent, comes from revenue increases. That contrasts with the one-third revenue, two-thirds spending-cut formula of the bipartisan Simpson-Bowles plan, and even more with Republican plans to balance the budget with spending cuts alone.

What disappoints me about the revenue side of the People's Budget is the degree to which it depends on higher marginal tax rates rather than on tax reform. The biggest piece of revenue, an estimated $873 billion, is to come from enacting Representative Jan Schakowsky's Fairness in Taxation Act (HR 1124), which would create several new income tax brackets, ranging from 45 percent on incomes over $1 million to 49 percent for incomes over $1 billion. The second biggest piece, $330 billion, is to come from Senator Bernie Sanders' Responsible Estate Tax Act (S 3533), which introduces estate tax rates up to 65 percent. Some smaller new taxes for the financial sector are added, as well.

The revenue estimates for the tax increases are set out in a technical analysis of the People's Budget prepared by the Economic Policy Institute. Those, in turn, rely on analysis by the Joint Committee on Taxation that has not been released to the public. From context, it would appear that we are looking at static estimates, which do not take into account behavioral responses to tax rate changes, in contrast to dynamic estimates, which do. Static scoring tends to overestimate the revenue from tax rate increases, although it is often hard to know by how much.

Popular discussions of dynamic scoring often focus on the idea that corporations and small businesses won't try as hard to innovate and create jobs if their tax rates go up. However, the real damage of higher marginal tax rates comes not from decreased work effort, but from increased efforts to avoid taxes. Given the complexity of the federal tax code, the possibilities for legal tax avoidance are almost limitless. Everyone has heard the horror stories: Warren Buffet pays a lower tax rate than his secretary; the corporate giant General Electric no tax at all.

Tax avoidance does not just reduce revenues; it leads to efficiency-killing distortions when investment decisions or operational strategies are modified to make income from one source look like something else from somewhere else. Raising marginal tax rates only makes the problem worse. Tax reform that keeps marginal tax rates low while closing loopholes is a much better strategy. Reform could raise as much, or more, revenue than boosting rates, while reducing opportunities for tax avoidance rather than increasing them.

To its credit, the People's Budget does close a few loopholes. For example, it equalizes the tax treatment of capital gains and ordinary income, although it sacrifices potential efficiency gains by raising the marginal rates on both. It leaves most itemized deductions in place, but does take the modest step of capping the degree to which top earners' taxes can be reduced. It eliminates the deductibility of municipal bond interest, although the deduction is replaced with a subsidy to municipal bond issuers that not everyone will like. It broadens the corporate tax base by eliminating oil and gas preferences and taxing foreign corporate income as it is earned, although it leaves the marginal corporate tax rate unchanged at what is already one of the highest in the world.

But these tax reform proposals are half-steps compared with what could have been done, in complete consistency with the progressive agenda. For example, why not repeal the mortgage interest deduction? As I noted in an earlier post, the Urban Institute-Brookings Tax Policy Center estimates the mortgage interest deduction to be worth $5,393 a year for tax units in the top 1 percent of the income distribution (average income $1,302,188) but only $215 per year to those in the middle 20 percent (average income $43,678). For households in the bottom 20 percent of the income distribution, the deduction has almost no value. Getting rid of the deduction would raise $108 billion in 2012, rising to $162 billion a year by 2019. What keeps the mortgage interest deduction off the progressive hit list? Who knows. Maybe campaign contributions from the United Brotherhood of Carpenters.

In all, the People's Budget leaves untouched the entire top half of the dirty-dozen list of tax loopholes. All of those loopholes—from employer-paid health care to mortgage interest to charitable deductions—are regressive in their impact. All of them encourage efficiency-sapping tax avoidance strategies, the effects of which would be even worse if the higher marginal rates of the People's Budget were to be enacted. Collectively, eliminating the top six loopholes could raise close to $500 billion a year in added revenue, enough to pay for a cornucopia of progressive delights.

The bottom line: The People's budget does represent a real alternative to Republican budget plans. It takes on some sacred cows that the Republicans fear to touch, most notably defense spending. It correctly recognizes that cuts to infrastructure investment are false economies that reduce the headline deficit number without really improving the national balance sheet. It also deserves credit for seeing that real cost savings, not just cost shifting, will be needed to make health care affordable.

Finally, the People's Budget is more realistic than Republican plans in recognizing that both spending cuts and revenue increases will be needed to close the budget gap. Sadly, though, the way it seeks added revenue is just plain bad. Its "millionaire's tax" plays to the class warfare instincts of the progressive base, but its efforts fall flat when it comes to tax reform. The People's Budget could have been very much better, and without giving an inch on its progressive principles.

Follow this link to view or download a short slideshow with graphs, data, and other highlights from the People's Budget.

2 comments:

This is great. I think we have similar opinions as well. In fact, a similar take is depicted in our cartoon called "Route Causes" at http://www.youtube.com/watch?feature=player_embedded&v=4yQwZ2B10uU. The project, titled Route Causes, follows the animated adventures of a traveling news crew, providing comedic perspective on current events. Please take a minute and watch it. Would love to hear your review.

Chris-- Nice cartoon. I recommend it to anyone who wants a little comic relief for themselves or their students. Watch out though, it uses some comic exaggeration with regard to US inflation. It uses an example of tickets to a Beatles concert, which cost $5 when the group was new, but would cost $250 now (based on the price of tickets to comparable groups). I'm sure the 50-fold increase in rock ticket prices is valid, but that's a lot faster than the increase in US consumer prices in general.

Just for the record, starting from 1960, the year the Beatles started, the price level doubled by 1976 (16 years), doubled again by 1988 (12 years), but then slowed down, and have not quite doubled again today (23 years). So if tickets had increased at the rate of the consumer price index in general, they would only have gone up from $5 to $40.

Still, the cartoon makes one very valid point: If Congress does not want to cut spending, and does not want to raise taxes, inflation would be a third way to get rid of the national debt, just as happened in Germany in the 1920s.

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